A Review of "Mis-Inflation: The Truth About Inflation, Pricing, and the Creation of Wealth"
In a recent podcast, I heard David Bahnsen discuss his new book, co-authored with Douglas Wilson, titled "Mis-Inflation: The Truth About Inflation, Pricing, and the Creation of Wealth." His arguments sounded very interesting to me, so I read the book and found it very intriguing. Much of the book flies in the face of traditional expectations regarding inflation in particular, but the book touches on many topics. Both Bahnsen and Wilson are Christians and incorporate a Biblical worldview into their arguments, though I believe that non-Christians will still find significant value in the book.
In this review, I would like to provide a high-level view of what I believe to be the key points of the book. Those interested in more details would do very well to read the book themselves.
The book is written as a series of letters between Bahnsen, a Christian economist, and Wilson, a pastor. Wilson presents himself as a "layman in the realm of economics" and questions why the inflation that many 'hard money advocates' have been expecting to manifest itself for decades now hasn't shown up. Through a back and forth exchanged, Bahnsen provides an answer, and it's not what Wilson, nor I, despite having a Ph.D. in business, expected.
First, Bahnsen agrees with Friedman and other economists that inflation is the result of "too much money chasing too few goods and services." He goes on to say that inflation is a function of both the money supply and the velocity of money (i.e., how quickly money moves through the economy). These have long been my own understanding of how inflation works, though many erroneously believe that inflation is only due to the size of the money supply (more on that below).
But Bahnsen argues that in the existing banking system, central banks like the Federal Reserve cannot actually create new money. Rather, when the Fed buys U.S. Treasury bonds from banks, it is merely swapping one asset for another, namely, cash for Treasuries. The private sector doesn't end up with more assets, only different assets. Money is actually created only when banks loan out their reserves. If banks don't loan out their reserves, then the massive quantitative easing we've seen since the Great Financial Crisis of 2008-2009 merely results in banks having massive reserves, which is precisely what has happened.
To many, such an assertion might sound incredible, so much as to be nigh on ridiculous. But the data support it. Take a look below at what happened to the M2 money supply from 2009-2021.
The M2 money supply increased from $8.3 trillion to $21.5 trillion, a 159% increase, over this period, yet the Consumer Price Index only increased by 32% during this time. Clearly, an increased money supply, at least as measured by M2, alone does not create inflation.
Over the same period, the velocity of the M2 money supply declined dramatically from 1.735 to 1.142. Most of the newly added money to the system didn't work its way through the economy. And that is why inflation over this period was only a small fraction of the increase in the money supply.
To put it simply, an increased money supply does not result in inflation if the additional money merely sits on banks' balance sheets.
Under the current system, inflation can only arise when those in the private sector, whether businesses or individuals, borrow money. And there are limits to how much the private sector will borrow. There are only so many qualified borrowers, and there are only so many projects for the private sector to invest in at any given point in time. The Fed cannot create more qualified borrowers or projects for them to invest in. When the private sector has borrowed all it can, the potential for additional inflation is gone.
This leads directly to a key part of Bahnsen's argument. Inflation is limited by the ability of the private sector to borrow, but deficit spending by the federal government has a substantial deflationary impact. The reason is simple: when the government engages in deficit spending, it is pulling future growth into the present. This is akin to a family borrowing to buy a new TV today and planning to pay it off with a bonus next year. When the bonus comes, there is no growth for the family because the funds were already spent, and it's actually worse than that due to the interest on the debt.
But there is diminishing marginal utility from such spending. Additional dollars spent provide less and less additional value, and this is certainly true for the federal government. Money spent by the federal government is less productive than if the money was spent by the private sector. If this weren't the case, then so-called command economies would be superior, and we have mountains of empirical data to demonstrate that they are decidedly economically inferior to capitalistic economies.
As such, the more deficit spending by the government, the less efficient the overall economy, and the more downward pressure is put on inflation. Bahnsen repeatedly cites Japan as a prime example of this. The debt to GDP ratio in Japan has steadily grown over the last several decades to the point that it is now over 260%. All that deficit spending didn't result in rampant inflation. On the contrary, from 1991-2022, inflation in Japan averaged just .35% annually. But of even greater importance, the Japanese GDP only grew at an average rate of 0.75%.
And Bahnsen is concerned that the U.S. is largely going down the same path, though he admits that the U.S. has several things going for it that Japan did not and does not, such as being the source of the world's reserve currency and a more favorable fertility rate, though that is declining. The U.S.'s debt to GDP ratio rose from 40% in 1966 to 63% at the end of 2007, but it now stands at 120%. Such high levels of debt have a deflationary effect and are reducing future economic growth. And the problem is compounded by the fact that the federal government and the Fed are working in concert to exacerbate the problem, as Bahnsen states below.
"We have decided that our treatment for a patient who gets sick with too much debt (in the case of 2008, it was too much household debt) is more debt. We moved the debt from the balance sheet of households to the government, and now require a fiscal and monetary hair of the dog to prevent the hangover, in perpetuity. Low growth? Increase fiscal. Fiscal too expensive? Increase monetary. Monetary leads to a bubble the mis-prices risk and causes an asset liquidation? Treat it with more fiscal and more monetary."
Bahnsen contends that such high levels of public debt combined with these methods of perpetually 'kicking the can down the road' have already stifled economic growth (vis-à-vis the significantly below average growth in GDP since 2009) and will only gain momentum in doing so.
As such, the long-term concern is not runaway inflation but economic stagnation. Further, they argue that risk-taking entrepreneurs are what we really need more of, and the stewardship mandate of Christians, in particular, should drive them
The authors discuss many other factors, such as what would be necessary to 'fix' the national debt, problems with the 'gold bug' mentality, and the inverse relationship between self-government and the size of deficit spending. There are a couple of things that I don't entirely agree with, such as Bahnsen's claim that there isn't a meaningful aggregate inflation rate, but the book is well written, very thought provoking, and certainly worth reading.